Fed Rate Cut Likely

By Colin Twiggs
November 29, 2007 2:00 a.m. ET (6:00 p.m. AET)

These extracts from my trading diary are for educational purposes and should not be interpreted as investment advice. Full terms and conditions can be found at Terms of Use.

Dow Failed Breakout

The Dow reversed, penetrating the upper trend channel, after a failed break below primary support at 12800. One of the biggest mistakes analysts/traders can make is gathering evidence to support their existing position rather than opening their mind to new possibilities. Another common mistake, however, is to shift your position back and forth in response to each new piece of evidence — before their is clear proof that you are on the wrong track.

dow jones industrial average short-term

Probability may have shifted slightly with Wednesday's strong blue candle, from say 80 per cent to 75 per cent, but remains firmly in favor of a bear market. A higher trough, as with the FTSE below, would increase the contrary evidence, while reversal below 12800 would push the probability back above 80 per cent.

ftse 100 index

The Shanghai Composite index broke through support at 5000, indicating that the secondary correction is likely to test support at 4300.

shanghai composite index

Treasury Yields

Ten-year treasury yields recovered above support at 4.0%, after a sharp fall in anticipation of further rate cuts from the Fed. The yield differential (10-year minus 3-month treasury yields) is above 1 per cent, but damage to the economy was done 6 months ago, when the spread fell below zero.

10 year treasury yields and yield differential with 3 month treasury bills

Bank Lending

Bank credit continues to grow at above 10 per cent a year.

bank loans and leases

The real contraction is taking place off-balance sheet, however, as shown by the sharp decline in asset-backed commercial paper.

commercial paper outstanding balances

Citigroup is the first banking group to show the effects of subprime write-downs on its capital base, being forced to secure a $7.5 billion infusion of Tier 1 capital from Abu Dhabi Investment Authority, in order to maintain its capital adequacy ratios. Expect other banks to follow before the housing collapse is over.

Financial Markets

Treasury bill (3-month) yields are testing support at 3.00%, while rates on asset-backed securities and financial paper continue rising. The widening spread warns of further upheaval in financial markets.

commercial paper rates compared to federal funds rate and treasury bills

The effective federal funds rate fell below the Fed target of 4.5% for a second time, indicating that further rate cuts are likely.

I believe that Jonathan Wright's recession prediction model has failed to adequately address the damage caused by a negative yield curve in a low interest rate environment. The model currently shows a slight up-tick in the probability of a recession in the next four quarters, to 16 percent.

wright's recession prediction model

Its not whether you are right or wrong that matters, but how much money you make when your right and how much you don't lose when your wrong.

~ George Soros

To understand my approach, please read Technical Analysis & Predictions in About The Trading Diary.